NAB Employs Mark to Fantasy to Mask Losses

It seems NAB is employing the same mark to fantasy accounting treatments as US banks. According to law firm Maurice Blackburn, NAB failed to disclose the true value of its exposure to toxic CDO’s. From the Daily Telegraph:

NAB’s toxic debt digging a $4bn black hole

NATIONAL Australia Bank could be prompted into a capital raising to cover losses of almost $4 billion from its portfolio of toxic debt that is being investigated by the nation’s prudential regulator, analysts said.

The Australian Prudential Regulation Authority has been in talks with NAB for two months over the most appropriate method to value the $17 billion toxic debt portfolio.

The structured credit portfolio was held in nabCapital and includes corporate bonds, commercial mortgage backed securities, collateralised debt obligations (CDOs) and synthetic CDOs (SCDOs).

All are being held on a hold-to-maturity basis and analysts say any writedowns could cost shareholders $3.9 billion.

CLSA Asia Pacific Markets bank analyst Brian Johnson said if NAB applied current market valuations the fair value of the portfolio would be $3.9 billion below the current carrying value set by the bank.

“NAB has only brought back on to the balance sheet the $18 billion of debt issued by the conduits that they have purchased and not the underlying assets themselves,” Mr Johnson wrote in a client report recently.

NAB booked a $1.441 billion loss provision on CDOs in the portfolio since March 2008 but has yet to mark the value of the instruments to market, which could result in more writedowns.

So far, the provisions have been set by NAB’s internal credit risk ratings.

APRA told NAB earlier this year that it expected provisions to take into account market values, scenario-based losses, default and loss experience on similar instruments published by ratings agencies, as well as the bank’s own internal credit risk ratings.

Mr Johnson said more loan loss provisions could see APRA increase NAB’s tier one capital level to account for expected losses and the $3.9 billion valuation gap.

Others say it is difficult to value the debt within the conduits and so far there is nothing to suggest holding the portfolio to maturity is the wrong course of action.

The timing of NAB writedowns in 2008 has been put under the spotlight by law firm Maurice Blackburn, which alleges the bank failed to disclose to shareholders the true value of its CDOs.

Maurice Blackburn contends the first provision announced in May 2008 was only about 15 per cent of the face value of the CDOs.

It said the bank should have made a larger provision given conditions in US markets that existed between January and May 2008.

It would be surprising to see the Australian regulatory authorities force banks to mark to market since their US counter-parties have decided to bury their collective heads in the sand. However, even if NAB doesn’t mark to market, risks remain that toxic assets will need to be further written down to some degree. That of course means more capital raising and/or dividend cuts, which in my opinion is likely anyway for all the major banks in the next 12 months.

Consider the latest data on impaired assets in the quarter ended March 2009 released by the RBA last month. Impaired loans as a percentage of total loans now stand at 0.95%, the highest since June 1996. Still, by historical standards this is not terrible and certainly not anywhere near the levels of the early 90′s, but the trend is not the friend of the major bank’s.

Rising impaired assets means more write-offs which means more capital to absorb those write-offs. Throw in some dubious accounting treatments on toxic assets and you have significant downside risk here for NAB.